The New York Times' About.com has a list of the five greatest investing movies of all time. You may be stunned to find that National Lampoon's Christmas Vacation is not included on that list. But when I saw that a Lehman Brothers (NYSE:LEH) analyst had downgraded Irish pharmaceutical company Elan (NYSE:ELN), I was reminded immediately of a scene in the Chevy Chase holiday classic.
If you've seen the movie, you know what I'm talking about. The house is quiet. The doorbell rings. You can hear commotion outside. The doorbell rings again, more ominously. Then again. And again. It sounds like a dirge. The door opens. It's the grandparents. And they're bickering.
Chaos has arrived.
Some say you are a very bad man
Elan is one of a certain breed of company that attracts large numbers of individual shareholders who are, shall we say, passionate. Any threat, perceived or real, to their investment dollars is met with a nearly (OK, entirely) irrational rage. As someone who has publicly mentioned my own stake in Elan in the past, I anticipated a raft of emails from dozens of enraged shareholders demanding that I expose Lehman and its analyst, Richard Silver, as being (take your pick) hopelessly corrupt, stupid, evil, a horrendous dancer, and any other adjective that might befit someone who had helped cause Elan's stock to drop 18% in two trading days.
Sure enough, the emails plowed in. Declarations of war, calls for boycotts, bile, invective thrown not only at Silver and Lehman, but also at Biogen IDEC (NASDAQ:BIIB), Elan's partner for Tysabri, its drug for the treatment of multiple sclerosis. Everything was there, except for the one thing that would have done anyone any good: a dispassionate view of the facts and/or the thesis Silver laid out. Conspiracies and plots galore, yes. Analytical rebuttal, not so much.
It would be wonderful if these nervous Nellies would relax just a little bit. It would be even more wonderful if they recognized the following: The fact that Elan dropped so much had more to do with a bunch of speculators being on a hair-trigger than with some analyst's opinion. Acting like cultists doesn't do a lick of good -- in fact, it's pretty harmful.
At its worst, savaging those who disagree means that you must be willing to throw the wise counsel out with the bad. I have enough hate mail from the supporters of erstwhile Beyond.com, Internet Capital Group (NASDAQ:ICGE), Sirius (NASDAQ:SIRI), Travelzoo (NASDAQ:TZOO), and other old highfliers from back in the day to know that this is just how some people react to contrary opinions. But there is nothing healthy about it.
Still, there are some funny things about Silver's research at any rate. Here's the methodology component from his most recent report:
Given Elan and Biogen's recent Tysabri sBLA submission for MS and confidence in FDA approval during 2006, our NPV model now assumes a 75% probability of Tysabri reaching the market for [multiple sclerosis] in 2007, compared to prior 25% probability and 2008 launch assumptions. Additionally, we are now assigning 0% probability to Tysabri in [rheumatoid arthritis] indication as the program is being terminated due to unfavorable Phase 2 results. With our peak Tysabri sales estimates of $490M in MS and $263M in Crohn's unchanged, we now estimate Tysabri contributes $1.70/share to Elan's NPV, up from previous $1.15. For rest of the business, we estimate NPV contribution of just over $5, down from previous $6, primarily due to change in Pharma Pipeline methodology in calculating NPV. After subtracting about $2.0/share in net debt, we arrive at a price target of $5 (vs. $6 previously), which is below where Elan shares are currently trading.
Compare that with his report from July 2005, which says, in part:
Our NPV model assumes a 25% probability of Tysabri returning to the market for all indications which equates to ~ $1B in peak global sales ($490M in MS, $260M in Crohn's, and $300M in RA). Tysabri revenues of $1B translates into NPV of $1.15 plus another $6.00 for the rest of the business equals ~ $7. After subtracting ~ $1.50 in net debt, we arrive at our price target of $6 which is just below where Elan shares are currently trading.
More likely = worth less?
In July, Silver assumed a 25% probability of Tysabri returning to build out his valuation, while he has now upped that estimate to a 75% chance. (I believe that the probability now exceeds 95%). So how is it possible that the peak cash flows from Tysabri, which were approximately $750 million in both models, are valued only slightly higher today ($1.70 versus $1.15), when by Silver's model they are three times more likely to occur? The answer lies partially in his eliminating any revenues for rheumatoid arthritis, but given that any revenues were several years out in the best case, I'm somewhat staggered that he'd modeled a present value that would have such a remarkable impact.
And how would net debt be worth $0.50 more per share when net debt is at comparable levels to where it was in July?
My own take on Elan is that, at $16, it had gotten a little ahead of itself. Given that Tysabri has yet to return to market, and for all of the confidence that shareholders have that it will return to market following a Food and Drug Administration hearing in March, it had sold a little up there as a result. So when Silver says "at nearly $17 per share, Elan's valuation more than fully reflects a successful upcoming FDA panel meeting, market re-entry, and future peak sales well in excess of even the most optimistic scenarios," I don't necessarily disagree. The quick and easy money on Elan has been made at this point.
I also think that Silver's $5 valuation of the company -- valuing it on what is essentially a liquidation basis -- is just plain wrong. He discounts the potential to treat Crohn's disease (in a market where the alternatives are really, really nasty); he discounts the potential for an Alzheimer's drug; he discounts the potential for nanocrystals. Perhaps that's pertinent. But let's face facts: He didn't change his target price on the company. He changed the rating. His rating was completely out of whack: a $5 price target on a $16 company does not equal "hold." That's a "sell," and that's what he did. I have no problem with that, even if I disagree.
But how does one come up with substantially more optimistic projections (which I believe are low), with less time before they might be realized, and calculate a lower valuation? That, I don't really get. But even that makes more sense to me than why anybody should put so much weight on what an analyst thinks when making an investment decision.
Bill Mann owns shares in Elan Pharmaceuticals. He is the co-advisor of the Motley Fool Hidden Gems newsletter, where you can get his and Tom Gardner's top small-cap stock ideas each month. A free30-day trialis, in fact, free. The Motley Fool has a disclosure policy.
